Big import duty cuts will boost economy

17-Dec-2018

Big import duty cuts will boost economy

Finance Minister Arun Jaitley, speaking at an official event on December 4, made a strong case for lowering of import duties. Higher the tariff, bigger the evasion across sectors, he said. This is most welcome. Lower import duties will for sure create conditions for high growth in trade and investment and help the economy in at least four ways.

One, increase India’s export. Lower duties will remove a big structural weakness of India’s exports by enabling participation in the global value chains (GVCs). Products manufactured in GVCs account for two-thirds of world trade, but India’s share is meagre.

What’s the reason for a low share in GVCs? Mainly, import duties and time taken at the port/Customs. Since the complex production process requires goods to cross borders several times at different stages, any duty charged has a cascading and accumulative effect on trade. A reduction in import duty and quick clearances at the port/Customs will improve the situation and help Indian exports.

Two, improve ease of doing business. For industrial goods, India’s average rate of import duty is 10.2 per cent while the weighted average import duty is only 5.7 per cent. The significant difference in the two numbers is because some of the key imports attract low duty and large value of imports are allowed end-use specific exemptions. Lower duties will do away with the need for grant of many exemptions which make implementation complex. High duties also lead to smuggling, evasion, litigation, and corruption.

Three, reduce the need for most export schemes. Many exporters use duty exemption schemes to import inputs and machinery needed for making an export product at zero duty. Low import duties will reduce the need for such export schemes. Low duties will reduce the outgo under the drawback scheme, which allows a refund to the firm which uses duty-paid inputs. Further, higher the duties, higher the allure to take more than is due through over-invoicing of exports. Duty reduction will make export schemes simple to administer and reduce the hassle of exporters.

Four, more robust trade policy regime. For example, low duties will reduce the adverse effects of free trade agreements (FTAs) on domestic industry. High tariff means high protection to domestic industry. If the high wall crumbles as a result of FTA, the industry gets a big shock when a high import duty country enters into an FTA — substantial trade shifts from most efficient supplier to the FTA partner as the latter supplies without high duties. Import duty in most of India’s FTA partners is lower compared to India. This means their firms gain more price advantage compared to Indian counterparts. Reform of Customs duty regime should ideally precede signing of any mega FTA.

Before proceeding, we must address concerns of naysayers. They say: If duties are low, who will make in India? Does high duty wall bring investment? Global car majors invested in India on account of very high import wall. Would they go back? Will lower duties lead to a surge in imports? China and South Korea have high duties?

Trade and duties are inversely related. Between 1991 and 2018, while average import duties came down from 128 per cent to 10.2 per cent, India’s merchandise trade (exports and imports) rose from $37 billion to $770 billion.

Also, no surge of unwanted import happened during this time. China and Korea mainly use NTBs to protect unwanted imports. Also, their large scale imports happen through FTAs.

Two-step plan

One, a broad look at India’s imports of $465 in FY18 should be the starting point. India’s schedule has 11,500 tariff lines. Value-wise, the top 50 per cent imports are concentrated in only 25 lines relating to crude oil, gold, diamonds, mobile phones, telecom products, etc. Except for gold all others are low-duty products. Next, value-wise, the top 90 per cent of imports are concentrated in just 1,000 lines. Also, there are only 5,300 lines on which imports cross $1 million.

Next, let us get an idea of the import duty collected. India collects more than 85 per cent of basic customs duty from less than 10 per cent of tariff lines.

Also, the bottom 60 per cent tariff lines contribute to less than 3 per cent of revenue. Within this framework, we may carry out a nuanced reduction in basic customs duties.

For example, we may identify 15 per cent of industrial tariff lines as strategic and retain the current level of duty on these.

These may include items on which we wish to invite FDI for manufacturing. Then, we may reduce duties on most raw materials and intermediate goods. For the remaining industrial products, India may move to 5 per cent duty regime in the next five years. For agriculture products, a detailed product-level approach would be needed.

Two, set up quality and standard infrastructure. Simple average import duties on industrial goods in Canada, Japan, Australia, the US, and the EU vary between 2 per cent and 4 per cent.

This does not mean that these countries allow free access to foreign products. They have switched to use of non-tariff barriers such as product standards to control unwanted imports.

India also needs to create such a set-up for important products. Lower duty regime works best in tandem with elaborate standards and non-tariff measures regime.

We need to take the call and announce a five-year schedule for a reduction in duties. Any reduction in duty can be reverted without violating our commitments at the WTO.